Is the Dollar Still the Hedger's Paradise?


At a press conference on March 13 following the close of the second session of the 11th National People’s Congress, Premier Wen Jiabao said, “We have lent a great deal of money to America, and of course we are concerned with the security of our assets. To be honest, I am a bit anxious. Therefore, to reiterate, I demand that America maintain its credit, abide by its commitments, and guarantee the security of China’s assets.” He emphasized, on the question of the foreign reserve, that our priority is to protect the national interest. At the same time, we must also consider the stability of international finance as a whole, since the two are interconnected.

On March 14, President Obama issued a response. He indicated that investors, not just the Chinese government, should all have absolute confidence in the security of their investments in the U.S.–treasury bonds and government bonds, plus private sector, industrial and commercial investments.

On March 16, the U.S. treasury released its latest TIC (Treasury International Capital) report. The report showed, as of the end of January 2009, China held $739.6 billion in U.S. treasury bonds, more than $100 billion greater than Japan’s holdings (the second largest), accounting for 7 percent of U.S. foreign debt.

At the same time, data shows, at the end of January, foreign-held U.S. treasury bills were down $4.7 billion from the previous month. This is the first time since March 2007 that foreign holdings of American debt have gone down. China’s purchases of treasury bonds will also obviously slow down, increasing $12.2 billion from December to January – the lowest increase in China’s treasury bond holdings since the first half of last year.

China International Finance Corporation’s chief economist Ha Jiming thinks that China’s foreign currency reserves may have fallen from January to February. He recommends, in the short term, that China still buy U.S. treasuries; since other countries and regions are deteriorating to an even greater extent, the dollar may still have higher value compared with other currencies. In the long run, China should commit to reforming its exchange rates and upgrading the international status of the RMB.

The changes in foreign reserves can be broken down into five components: trade surplus, net inflow of foreign direct investment, investment income, exchange rate shifts, an an “unexplainable” part. Ha Jiming noticed, from January to February, the monthly trade surplus was only $22 billion, a notable drop; FDI inflows also slowed significantly; in the same period, the prices of U.S. treasuries and institutional debt held in China’s foreign reserves dropped, while exchange rate losses among non-dollar assets also rose substantially (since January 2009, the euro has fallen more than 9% against the dollar). If the “unexplainable” assumption is invalid – that is, if there are no short-term capital outflows – he expects foreign reserves to fall by $30 billion. If the “unexplainable” component maintains its 2008 momentum, then foreign reserves may have shrunk by $1.3 trillion from January to February.

What implications does the shrinkage in foreign reserves have for managing the foreign reserve? Ha Jiming thinks that the composition of the foreign reserves should be “buy U.S. debt in the short run, buy resources in the long run.” He explained that, in the short run, U.S. debt is still the best current choice for foreign reserves. Though the markets have had doubts about whether the U.S. dollar can maintain its position as the world’s international reserve currency, the pace of deterioration in Europe, Japan and the emerging markets has overtaken that of the U.S., and furthermore, mounting risk-aversion in the markets will support the dollar.

He said, for China, buying U.S. treasury bonds is also a sensible investment. The reason is simple – other currencies are depreciating against the dollar, so investing in other currencies will result in a loss. At the same time, U.S. assets are already appreciating. “On one side, there’s a substantial loss – on the other, there’s a positive return; there’s no doubt about which choice to make.”

Therefore, Ha Jimin proposes that “in the short term, foreign reserves should be used to buy up U.S. debt – the sooner, the better.” During the rescue process, America needs to issue bonds or print money to finance its operations. Needless to say, the U.S. Treasury is trying to persuade other countries (including China, Japan and oil-exporting countries) to buy its bonds. If these countries refuse to buy, America may finally be forced to print money, causing a significant devaluation of these countries’ dollar-denominated reserve assets. Therefore, China should buy U.S. treasury bonds, and furthermore, should push other countries to promptly do the same. China and America should cooperate to resolve their common problems.

If America cannot obtain help from the international community, in the end it will only be able to print money, causing a devaluation of other countries’ hard-earned dollar reserves. If China buys U.S. debt – and furthermore, convinces other countries to buy – China will benefit from the resulting rise in bond prices and the strengthening dollar.

He also points out, through this cooperative process, China could strive to reach a number of beneficial agreements, demanding, for instance, that it loosen the ban on sales of high technology, among other things.

Concerning the recommendation to purchase resources, Ha Jiming explained that for the official reserve management agency to carry out a large-scale buying operation for resources and other non-liquid assets would be completely unrealistic. Therefore “China should further diversify its foreign investment by increasing the flexibility and volatility of the RMB and by broadening its exchange rate reforms, allowing the private sector to increase its demand for dollar and supporting companies that go out and buy up resources.”

In the long run, Ha Jiming thinks we should work harder to raise the RMB’s status as an international currency. To be sure, the scale of China’s economy is still small compared with that of the U.S. or Europe; furthermore, with the RMB not yet fully convertible, it will be difficult in the short-run for it to join the ranks of the leading international reserve currencies. Moreover, choices about reserve currencies are not simply determined by a country’s economic strength – politics, international relations, military affairs and other factors also play an important role. At present, the U.S. is the only country with veto power in the IMF, and the U.S. dollar’s international status will be hard to shake in the short-term.

But, Ha Jiming has said in recent years, the development of Asian regional trade and tourism has made the RMB freely convertible in many countries, and efforts should be made to consolidate and develop the RMB’s status in Asia as the leading regional reserve currency.

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1 Comment

  1. america is a failed state but can continue looking like a recession as long as the world and china loans us money.

    what did you expect obama to say dont loan us money? he is depending on it.

    china knows little about america and its decline.

    it is too caught up in returning to a better time when americans bought chinese products by the billions.

    china is in as much denial as america as to the state of america. both are caught up in a mutual materialistic agenda. corp profits for america and jobs for the chinese.

    america is no longer a creator of wealth but a spender of wealth. others wealth.

    the last 30 years is proof of that but few want to see it. after all we have hope in america that things will get better even while we build tent cities and one in fifty american children are homeless.

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